Select Committee on Work and Pensions Second Report


SECOND REPORT


The Work and Pensions Committee has agreed to the following Report:

PENSION CREDIT

SUMMARY

  
The Pension Credit is the next stage in the Government's pension reform programme. It will be introduced across Great Britain in October 2003 at a cost of approximately £2 billion per year. It will provide a guaranteed income for all pensioners and a 'reward' for those with small-scale savings and second incomes. Through the Credit, the Government aims not only to target pensioner poverty but also to increase the incentives to save for future generations. It is accompanied by changes to the way capital is treated in the Minimum Income Guarantee (MIG). This Report sets out the findings of our inquiry into the Credit's aims and into the details of its regulation and administration.
  
From the evidence we have received, we conclude that the Pension Credit has the potential to go some considerable way toward achieving the aims set down for it by the Government, especially by providing an immediate boost to pensioner incomes. It will ensure that most pensioners will be better off as a result of having saved for their retirement, compared to those who have not. This is not true under the current system, where many pensioners with some second income feel penalised for having saved as they have the same final weekly income as those who have not, owing to the operation of the MIG. The system of assessing entitlement to the Credit, especially the use of five-year assessment periods, should also bring many benefits.
  
However, in our Report we raise a number of specific concerns about both the operation and the role of the Pension Credit. We urge the Government, subject to affordability, to alter the rules governing the calculation of entitlement to the Credit in order to allow all second income to be rewarded, not just that above the level of the full Basic State Pension. This would ensure that it 'always pays to save'. We also recommend that the disregard for small amounts of weekly earnings be increased, to encourage continued participation in the labour market. The Credit will be administered by the new Pensions Service (an executive agency of the DWP) and we are concerned that it may be unable to cope adequately with the demands of managing a benefit involving the means-testing of over five million pensioners. We stress, in particular, the necessity of the Government ensuring high levels of take-up amongst those eligible for the Credit, if it is to be considered a success; a major challenge for the fledgling agency.
  
The long-term cost of the Credit and the numbers of pensioners entitled both depend crucially on the future uprating of the Credit's value - both the guaranteed minimum income level and the level of income above which second income is rewarded. So far the Government has only produced three possible uprating scenarios for the uprating of the Credit, beyond 2006, with widely different implications for future cost and coverage. We strongly believe that the Government should reveal its long-term aspiration for the uprating of the Credit to allow greater certainty for all those involved in the long-term planning necessary for pension provision.
  
Looking at the Government's pensions strategy overall, we question how the Credit will interact with other policies already announced and whether it is, in fact, too complicated a measure to have a significant impact upon future saving behaviour. We are especially concerned that the Pension Credit appears to leave little, if any, role for the State Second Pension. As it is currently proposed, a person could work all their life, contributing to their second pension, and when they retire still be in receipt of means-tested benefit, undermining earlier Government aspirations. We urge the DWP to clarify the role of the State Second Pension as soon as possible.
  
At the time of this Report being published, the State Pension Credit Bill is passing through its legislative stages in Parliament. We hope that this Report will assist Members of both Houses during their debates on the Bill, as well as those administering it in the longer-term.

Introduction

1. The Pension Credit will be introduced across Great Britain in October 2003 at a cost of approximately £2 billion per year and involving over half of the pensioner population.[1] The Government has described it as the "third - and crucial - stage" of its pension reform programme, which will not only combat pensioner poverty but reward saving and encourage future generations to provide for their retirement. In this Report we set out the findings of our inquiry into the Credit's aims and into the detail of its regulation and administration. In general, we welcome the principles underpinning the Pension Credit and the extra spending that it represents and have found much to praise in the Government's proposals. We do raise a number of specific concerns, however, about how the Credit is to be calculated and administered, and about how it will relate to the other aspects of the Government's existing pensions strategy. We hope that our Report will not only be of immediate assistance to Members of the House, debating the State Pension Credit Bill as it passes through Parliament, but also to those interested in, and responsible for, the Credit's introduction and its longer-term evolution.

2. We launched our inquiry into the Government's proposals for the Pension Credit on 28 November, with particular reference to the following areas:

  • "the role of the new Credit in the Government's overall pensions strategy;
  • the method of uprating the Pension Credit and the long­term implications of the method chosen;
  • the effect of increased means­testing on incentives to save;
  • the ability of people on low and modest incomes to make the correct decision regarding future pension provision;
  • the impact of the Pension Credit on pensioner poverty;
  • the implications of the Pension Credit for the private pensions and insurance industries;
  • the proposed methods for claiming / assessing entitlement to the Credit, including the frequency of reassessment; and
  • the likely levels of take up."[2]

3. Since that time, the Committee has received twenty­seven memoranda from a range of individuals and organisations, and a number of useful background papers. We have taken oral evidence from five sets of witnesses: Ms Joanne Segars and Mr Christopher Curry, Association of British Insurers (ABI), and Mr Adrian Boulding, Legal and General; Mr Gordon Lishman OBE and Ms Sally West, Age Concern England, Mr Mervyn Kohler and Mr Richard Wilson, Help the Aged, Mr Rodney Bickerstaffe and Mr Tony Lynes, National Pensioners Convention (NPC); Mr Andrew Dilnot CBE and Mr Tom Clark, Institute for Fiscal Studies (IFS); Mr Peter Robinson and Mr Richard Brooks, Institute for Public Policy Research (IPPR), and Mr John Hawksworth, PricewaterhouseCoopers; and the Rt. Hon. Alistair Darling MP, Secretary of State for Work and Pensions, and Mr Paul Gray, Head of Pension and Disability Client Groups, Department for Work and Pensions (DWP). We are grateful to all those who have contributed to our inquiry. We should also like to express our especial gratitude to the Committee's Specialist Adviser for this inquiry: Ms Ruth Hancock, Senior Research Fellow at the Nuffield Community Care Studies Unit, University of Leicester. Her assistance throughout the course of the inquiry has been invaluable.

Background

GOVERNMENT'S PENSIONS STRATEGY

4. In the 1998 Green Paper A new contract for welfare: partnership in pensions, the Government set out its "plans for radical reform of the whole pension system."[3] These plans were based upon the principle outlined by the Prime Minister in the Paper's foreword, and often restated since: "We believe that those who can save for their retirement have the responsibility to do so, and the State must provide effective security for those who cannot." To this end, the Green Paper outlined how the pensions system would be reformed. Some parts would remain unchanged, such as the Basic State Pension; others would be altered - Income Support for pensioners would become the Minimum Income Guarantee for example, and new measures would be introduced to help achieve the Government's aims, for instance Stakeholder Pensions. Details of the different aspects of the pensions strategy are set out below.

Basic State Pension

  5. In the Green Paper, the Government stated that the Basic State Pension would, "remain as the foundation of retirement income for rich and poor alike" and this assertion has since been repeated in most official publications on the subject.[4] A full Basic State Pension is currently worth £75.50, per week, for a single person.[5] A married woman without a full contribution record can claim a Basic State Pension based on her husband's contributions, in which case she would receive a maximum of £45.20 while he was still alive (the 'married woman's rate') and the full rate after his death.[6] The Basic State Pension has been uprated with prices since 1980, which has led to criticism from some groups who have called for it to be linked to earnings.[7] The Government did, however, make above-inflation rises in the value of the Basic State Pension in 2001 and 2002 and has guaranteed minimum increases of £100 a year (£160 for couples) in future.[8] The level of the Basic State Pension is significant for the Pension Credit as it is only income above the level of the full Basic State Pension (single person or married couple's rate) that will be eligible for the savings credit.

Minimum Income Guarantee

  6. The Minimum Income Guarantee (MIG) replaced Income Support for pensioners and aimed to provide a safety net for poorer pensioners - a level of income below which no one, in theory, should fall. The Government hoped that the MIG would avoid the "stigma" that some pensioners associated with Income Support.[9] At present, the value of the MIG is £98.15 per week for a single person and £149.80 for a couple, with the previous differences in rates of payment according to age (older pensioners receiving more) having been abolished.[10] The value of the MIG was increased significantly in 2001 and 2002 and the Chancellor has given a commitment to raise it to £100, for a single pensioner, in April 2003.[11] In 1998, and since, the Government has indicated that the MIG is its preferred method for combatting pensioner poverty, rather than the Basic State Pension, "because help will go to those in greatest need, rather than to rich and poor pensioners alike".[12] The MIG will be subsumed within the Pension Credit when it is introduced.

SERPS / State Second Pension

  7. Since 1978, all employees earning more than the 'lower earnings limit' (broadly the level of the Basic State Pension) have been obliged to contribute to a second tier pension, either through the State Earnings Related Pension Scheme (SERPS) or a private pension. (In the latter case, employees either pay reduced National Insurance contributions or have a rebate of such contributions paid into a private pension.) SERPS aimed to provide a supplement to employees' Basic State Pension, proportional to their past earnings. So, for example, a pensioner who had earned £200 per week above the lower earnings limit would receive twice that of someone who had earned £100 above the limit. SERPS was, generally, the best value pension option available for lower earners who did not have access to a good occupational pension scheme or who changed jobs frequently.

8. In the Pensions Green Paper, however, the Government stated that: "Although SERPS is an efficient second pension, it is earnings-related. It does least for those on low incomes who have most difficulty in building up a good second pension."[13] To rectify this, the Paper announced that a new scheme, the State Second Pension (S2P), would be introduced, which would effectively be inversely related to earnings. It would be more generous to those on low incomes; defined as those earning between the National Insurance Lower Earnings Limit and a Lower Earnings Threshold (LET) of £9,000 in 1998 prices (£10,800 when implemented in April 2002). Employees in this salary range would have their contributions treated as if they had annual earnings at the LET when the S2P was calculated, regardless of their actual wage. (This will include those, such as carers, with a broken work record.) This group would, according to the Government, see "a substantial boost to their income".[14] Those with incomes up to £18,500 in 1998 prices (£24,600 as implemented in April 2002) would see "a more moderate increase", whilst those above that figure would receive the same return as under SERPS. The Government stated in 1998 that, at some point, S2P would "become a flat-rate scheme for those on lower earnings", i.e. a full S2P would be the same for everyone regardless of earnings. It was expected that the comparatively better returns from funded pensions would inspire most moderate- and higher-earners to contract out of S2P. The Government has not yet given a clear indication of when the scheme will go flat-rate, although it stated in the Green Paper that it envisaged it being "five years after the introduction of stakeholder pension schemes".[15]

9. The State Second Pension replaced SERPS on 1 April 2002, and from that date no new SERPS rights have been accrued. By 2051, S2P will have completely replaced SERPS. People retiring between 2002 and 2051, who have contributed to both types of pension, will have a pension based on a mixture of the two schemes. The Green Paper stated that: "These reforms mean that anyone who works throughout their working life will receive a total state pension above the rate of the minimum income guarantee."[16] Both SERPS and S2P provide a degree of compulsion toward second-tier pension provision for employees, but there has been no such compulsion for the self-employed. We shall examine the relationship between the S2P and the Pension Credit later in this Report.

Stakeholder Pensions

  10. Stakeholder Pensions, as set out in the Green Paper, were aimed at employees and the self-employed, earning around £9,000 to £20,000 per year, who did not have access to a good second pension but wished to contract out of S2P. They would combine, "the low overheads and high security of occupational pension schemes with the flexibility of the best personal pensions". They were introduced in April 2001 and are operated by private insurance firms according to minimum standards and an approved governance structure laid down by the Government.[17] The companies offering Stakeholder Pensions are only allowed to charge a 1% administration fee. All private firms, with more than five employees, who do not operate an occupational pension scheme, are obliged to provide access to such a scheme and collect contributions through their payroll, if employees join. The Association of British Insurers (ABI) estimated that 750,000 Stakeholder Pensions had been sold up to the end of March 2002.[18] The Government anticipated that the measures outlined in the Green Paper, including Stakeholder Pensions, would "over time" reverse the proportion of spending on pensions from 60% state / 40% private to 40% state/ 60% private.[19]

Other measures

  11. The Government has also introduced two other significant non-means-tested measures to help pensioners. Since 1 November 2001, all pensioners over the age of 75 have been eligible for a free TV licence, which would otherwise cost £112 (for a colour set).[20] For the winters of 2000/01 and 2001/02, all pensioner households received a £200 Winter Fuel Payment, a new benefit introduced by the Government for the winter of 1997 at £50 and progressively increased since then.[21]

PENSION CREDIT

Legislative background

  12. The then Department of Social Security (DSS) outlined the "next stage" of its pensions strategy in November 2000, with a consultation paper on the Pension Credit. It stated that the Credit would help provide a "decent and secure income in retirement" and "remove the penalties for saving".[22] The Government invited views on its detailed proposals and received over 400 replies from various organisations and individuals, 57 of which were subsequently made available to the public.[23] The main issues the replies dealt with included: means-testing; take-up; interaction with other benefits; complexity; and the treatment of capital.

13. In his pre-Budget statement on 27 November 2001, the Chancellor of the Exchequer, Rt. Hon. Gordon Brown MP, announced that he was setting aside £2 billion for the Pension Credit, which would be introduced in 2003 (later confirmed as October 2003, rather than April).[24] The Secretary of State for Work and Pensions, Rt. Hon. Alistair Darling MP, subsequently made a statement to the House and published 'The Pension Credit: the Government's proposals'.[25] The State Pension Credit Bill then started its progress through Parliament in the House of Lords, where it received its first reading in December 2001. After passing through its stages in the Lords, the Bill entered the Commons and at the time of producing our Report had just received its second reading.[26] For the benefit of this Committee, and our colleagues on the Treasury Committee, the Department produced a booklet setting out projections of the Credit's long-term costs, for which we are grateful.[27]

Details of the Credit

  14. The Pension Credit[28] will be introduced across Great Britain from October 2003. It contains two principal elements:

      (i)  a guarantee credit, which provides a minimum income for pensioners aged over 60;[29] and

      (ii)  a savings credit, which 'rewards' (in the Government's language) every pound of extra income for pensioners aged 65 and over with a 60p credit, within a specified range.

The guarantee credit derives from the MIG: it will replace it, by providing a 'safety net' for all pensioners. The savings credit is intended to combat what the DWP described as: "the long-standing complaint that the existing social security system penalises pensioners with modest occupational pension or savings."[30] This complaint is illustrated by the graph below, provided by the Institute for Fiscal Studies (IFS), which illustrates how small-scale savings income is treated under the current regime. (Throughout the Report we use the figures used by the DWP in their examples and literature.)

Figure 1: Illustrative budget constraint under the MIG, for a single pensioner[31]


15. The figure shows how a single pensioner's final income increases (represented on the vertical axis of the graph) as their pension and savings income increases ('non-means-tested benefit income', on the horizontal axis). As can be seen, the MIG brings all pensioner incomes up to the minimum income level £100). Under this system, however, all pensioners with a small income from savings or a second pension that brings them up to a level below the MIG find themselves no better off than those who have made no provision for their retirement. So, for example, a pensioner who had a full Basic State Pension of £77 per week plus £10 from an occupational pension, would find him/herself on the same final income (£100) as a pensioner who had made no such saving. The Pension Credit aims to tackle this problem, as illustrated in the graph below:

Figure 2: Effect of the Pension Credit on a single pensioner[32]


16. Under the Pension Credit, every pound of 'qualifying' income above the level of Basic State Pension is 'rewarded' by a 60p credit. So, in the example given in the previous paragraph, a pensioner with no income, apart from the Basic State Pension, would have a final weekly income of £100, while one with £10 from, say, an occupational pension would receive a higher income (£106). Thus, the DWP tells us, "pensioners who have saved for their retirement will gain from having done so."[33] Income from savings, private and occupational pensions and earnings will all be eligible for the savings credit.[34] Details of how the Credit is calculated, and some examples of how individual pensioners will gain, are given in the box overleaf.


Treatment of capital

  17. The Credit will be accompanied by the introduction of new rules for the treatment of capital by the benefits system. At present, all pensioners with more than £12,000 of savings are automatically excluded from any entitlement to the MIG. For those with savings below this level but above £6,000, it is, for the purpose of assessing their MIG entitlement, assumed that every £250 of capital generates a weekly return of £1 (i.e. 20.8% per annum on capital in this range). Under the Pension Credit, there will be no such upper capital limit. As for the MIG, all capital of less than £6,000 will be completely ignored in assessing entitlement. For capital above this level the assumed rate of interest will be halved. The Government estimates, however, that approximately 85% of pensioners eligible for the Credit will see any income received from capital completely ignored.[35]

Administration

  18. Like other benefits for pensioners, the Pension Credit will be administered by the Pension Service. This is a new executive agency of the DWP, established in April 2002, that is responsible for the delivery of state retirement pensions and related entitlements.[36] It will contact people shortly before they reach state retirement age and invite them to claim their pension entitlement, including the Pension Credit, by telephone or in writing (and, in the longer-term, over the Internet). Once they have applied they will be sent a statement of the details they have provided to the DWP, which they will be asked to confirm. After this initial assessment, the pensioner will receive a letter from the Pension Service explaining how their entitlement has been calculated and what to do if they feel it is incorrect.

19. One of the most significant changes from the assessment procedure used for the MIG, is that once the initial calculation has been made most pensioners should only need to re-claim the Pension Credit every five years. The Pension Service will assume that the pensioner's income is stable and simply make adjustments based on annual uprating policies. Importantly, the pensioner does not have to report any increase in their income until the next five year assessment. Claimants will, however, still need to report 'significant changes' in their lives, such as a change of address, getting married, the death of a partner, etc. In addition, they will be able to apply for a re-calculation of the Credit if their income drops. The Government hopes that pensioners will find this whole system less "intrusive and bureaucratic" than that presently used for the MIG where, at least in theory, pensioners need to report changes weekly.[37] There could, though, be difficulties for pensioners with part-time, or seasonal, employment if their pay-rates vary dramatically from week to week or month to month. Some averaging process should be incorporated into the assessment procedure to cope with this.


1   Ev 98, paras 8-9. Back

2   Committee Press Notice: New Inquiry: Pension Credit, 7 December 2001. Back

3   A new contract for welfare: partnership in pensions, DSS, December 1998, Cm 4179, p. iii. Back

4   Ibid., p. 3. For example see: The Pension Credit: a consultation paper, DSS, November 2000, Cm 4900, p. 12. Back

5   April 2002 rate. Back

6   DWP news release: Increases to those who need it most, Darling, 28 November 2001, CSD2811-IHNM. Back

7   See, for example: Ev 20, para 3.2; and Ev 29, para 6. Back

8   Commons Official Report, 28 November 2001, column 972. See: Pre-Budget Report, HM Treasury, November 2001, Cm 5318, p. 89. Back

9   A new contract for welfare: partnership in pensions, DSS, December 1998, Cm 4179, p. 4, para 21. Back

10   IbidBack

11   Commons Official Report, 27 November 2001, column 836. Back

12   A new contract for welfare: partnership in pensions, DSS, December 1998, Cm 4179, p. 4. Back

13   Ibid., p. 39. Back

14   Ibid., p. 41. Back

15   Ibid., p. 40. Back

16   Ibid., p. 4. Back

17   Ibid., p. 5. Back

18   One year on - Stakeholders revisited: Analysis prepared by the ABI, ABI, April 2002. See: www.abi.org.uk. Back

19   A new contract for welfare: partnership in pensions, DSS, Cm 4179, December 1998, p. 103, para 4. Back

20   £37.50 for a black and white set. See: www.tvlicensing.co.uk. Back

21   Ev 106, para 10. Back

22   The Pension Credit: a consultation paper, DSS, November 2000, Cm 4900, p. 1. Back

23   Pension Credit: Responses to the Consultation Paper Cm 4900 (three volumes), available from the DWP. Back

24   Commons Official Report, 27 November 2001, column 836. (Also see: ev. From SofS) Back

25   Commons Official Report, 28 November 2001, column 972 and The Pension Credit: the Government's proposals, DWP, November 2001. Back

26   For details of the Bill's progress, see: Lords Official Report, 18 December 2001, columns 139-193 (Second Reading); 24 January 2002, columns 1587-1646 and 1663-1690 (Committee); 29 January 2002, columns 76-114, 129-155 and 175-206 (Committee); 12 February 2002, columns 1266-1284 (Report); 25 February 2002 (Third Reading); and Commons Official Report, 25 March 2002, columns 597-675 (Second Reading). Back

27   The Pension Credit: long-term projections, DWP, January 2002. Back

28   Although the title of the Bill is the State Pension Credit Bill (our italics), the Government has made it known that the benefit itself will simply be known as the Pension Credit when launched. Back

29   The minimum qualifying age for the guarantee credit will rise by stages to 65 between 2010 and 2020, in line with the state pension age for women. Ev 99, para 3. Back

30   Ev 99, para 2. Back

31   Ev 44, figure 1. Notes: 2003 benefit rates assumed. Income disregards, taxation and other means­tested benefits ignored. Back

32   Ev 46, figure 2. Back

33   Ev 99, para 2. Back

34   Basic State Pension increments earned by pensioners who defer drawing their pensions beyond state pension age and, for couples, Basic State Pension above the married couples' rate (£123 in 2002) will also qualify for the savings credit. Back

35   Ev 99 para 5 and The Pension Credit: the Government's proposals, DWP, November 2001, p. 5. Also see: Ev 125, table 'Treatment of Capital'. Back

36   For details see: www.thepensionservice.gov.uk. Back

37   Ev 102, para 29. Back


 
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